Bianco Research L.L.C.

Size: px

Start display at page:

Download "Bianco Research L.L.C."

Damon Eaton
5 years ago
Views:

1 Bianco Research L.L.C. An Arbor Research & Trading Affiliated Company Independent Objective Original The Next Move In Interest Rates? Presentation Package February 12, 24 Long-Term Interest Rates - 19 to 23

2 Outlining The Bear Case - 1 Market Based Inflation Expectations Year "TIPS" Breakeven Inflation Rate Yield of the 1-Year Treasury Note minus the Yield of 1-Year TIPS Note "Shortest TIPS" Breakeven Inflation Rate Yield of the 6.25% of Feb 15, 27 Treasury Note minus the Yield of 3.375% Jan 15, 27 TIPS The CRB Index Bianco Research, L.L.C February 12, /31/22 12/2/22 1/3/23 2/4/23 3/8/23 4/9/23 5/11/23 6/12/23 7/14/23 8/15/23 9/16/23 1/18/23 11/19/23 12/21/23 1/22/24 2/23/ June to 283 major resistance 19-Year Trend Line May 1996 March Day Moving /18/24 1/2/198 4/16/1981 7/3/ /1/1983 2/25/1985 6/9/1986 9/21/1987 1/3/1989 4/17/199 7/3/ /9/1992 2/22/1994 6/7/1995 9/18/ /31/1997 4/19/1999 8/1/2 11/19/21 3/7/23

3 Outlining The Bear Case - 2 The year-over-year change of Q4 23 nominal GDP was 6.21%. This was 2.94% above the yield of the 5-year Treasury Note on December 31 (3.27%). After adjusting the year-over-year change in nominal GDP for supply, the calculated fair value for the 5-year Treasury Note rises to 7.6%. This is 433 basis points above the 5- year s yield on December 31. Given a static snapshot of the economy and supply, interest rates appear to be greatly under valued. What does this mean? We believe interest rates currently reflect the expectations of a significant slowing in the economy and/or a further narrowing of the deficit. Since it is improbable the deficit will actually narrow anytime soon, and will likely widen further, it is likely the current market expectations reflect the belief that the economy (nominal GDP) is going to slow in the future. However, in order for interest rates to stay at their current level, or move lower, fair value needs to plunge. This means a combination of much lower nominal GDP and/or a narrower deficit is not only expected, but it is already priced in. Notice, we use this fair value calculation to help us determine what the market is pricing in. We do not believe deviations from fair value mean interest rates are at the wrong level. Deviations from fair value only tell us what the market expects from the economy and the outlook for supply. The fact interest rates and fair value are far apart suggests the market has priced in, and expects, bad news looking ahead. 9% 8% 7% 6% 5% 4% 3% 2% 3% 2% 1% % -1% -2% -3% -4% -5% Difference between the Yield of the 5-year U.S. Treasury Note and The Calculated Fair Value Last (Dec 23) = -4.33% The Yield of the 5-year U.S. Treasury Note Versus Calculated Fair Value 5-Year Treasury Note (Thin Line) Calculated Fair Value (Thick Line) 9% 8% 7% 6% 5% 4% 3% 2% 3% 2% 1% % -1% -2% -3% -4% -5% Dec-89 Dec-9 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec- Dec-1 Dec-2 Dec-3 Bianco Research, L.L.C February 12, 24 3

Misunderstanding Foreign Central Bank Holdings Of Treasuries - 1 From Today s Newsclips The Wall Street Journal - Weak Dollar Keeps Rewarding U.S. Bond Market Access requires subscription By continuing to exert downward pressure on the U.

4 Misunderstanding Foreign Central Bank Holdings Of Treasuries - 1 From Today s Newsclips The Wall Street Journal - Weak Dollar Keeps Rewarding U.S. Bond Market Access requires subscription By continuing to exert downward pressure on the U.S. currency, investors ensure that foreign central banks will remain heavy buyers of U.S. Treasurys. The U.S. benefits, as a soaring budget deficit stimulates growth, a weak currency spurs exports, and low yields encourage consumer demand. The Financial Times - Richard Duncan: Japan's monetary alchemy may not yield gold Access requires subscription The most aggressive experiment in monetary policy ever conducted is now under way. Japan is printing yen in order to buy dollars in such extraordinary amounts that global interest rates are being held at much lower levels than would have prevailed otherwise. In essence, the Bank of Japan is carrying out the unorthodox monetary policy that the US Federal Reserve intimated it was considering in mid-23. In other words, the BoJ is creating money and buying US Treasury bonds, which is helping to drive down US interest rates and underwrite US economic growth - and, by extension, global growth. The stories above are telling us a weak dollar is bullish for bonds. The tone of these articles is "everybody has always known this was the case." However, six weeks earlier the reaction to a falling dollar was the polar opposite - foreigners were going to stop buying all Treasuries and plunge us into crisis (see the story below). What happened to this idea? We have a theory. Bond bearishness is rampant. The table below shows that virtually every economist collecting a paycheck thinks interest rates are headed higher (see the last line in red). Bill Gross is pulling money out of his own fund. So, the cognoscenti believe the natural state of the market is rising interest rates. The chart at the top of this block shows foreign central bank holdings of Treasuries and Agencies. From October 16, 22 to February 6, 24, foreign central bank holdings increased by $234 billion - over a quarter trillion dollars! Bianco Research, L.L.C February 12, 24 4

5 Misunderstanding Foreign Central Bank Holdings Of Treasuries - 2 Over this same period, the yield of the 1-year Treasury note is down all of 1 basis point (no typo)! The yield of 2-year Treasury note is actually up 1 basis point over the same period (again, no typo)! Interest rates have not fallen to begin with, so how can foreign central bank holdings be responsible for their drop? The answer, everybody is so bearish that the lack of rising interest rates is considered "unnatural." So they search for a reason to explain the lack of rising interest rates. The reason de jour is foreign central bank buying of Treasuries. We understand the bearish case. However, we have argued that the reason rates are not rising is the Fed is offering cheap financing with the funds rate at 1%. This alone is powerful enough to hold interest rates in the face of the obvious bearishness that has 96% of the crowd looking for higher interest rates. When will rates move higher? When the Fed raises rates (either by their own devices or markets that signal inflation worries - the falling dollar, rising commodities, TIPS breakevens -- force the Fed to change). This is why Greenspan's testimony today is so important. Will he end the cheap financing party? Tune in at 11AM ET to find out. Bianco Research, L.L.C February 12, 24 5

6 Domestic Flows 3 Monthly Net New Cash Flow into Bond Mutual Funds Bianco Research, L.L.C February 12, 24 6 billions of dollars billions of dollars 87 The 5-Year Total Return Treasury Index and Total Bank Holdings of U.S. Government Securities 6/4/ Month Rolling Sum of Net New Cash Flow into Bond Funds ,17 1,13 1,9 1,5 1, billions of dollars Dec-84 Dec-85 Dec-86 Dec-87 Dec-88 Dec-89 Dec-9 Dec-91 Dec-92 Dec-93 Dec-94 Dec-95 Dec-96 Dec-97 Dec-98 Dec-99 Dec- Dec-1 Dec-2 Dec-3 billions of dollars 12/31/1997 4/1/1998 7/1/1998 9/3/ /3/1998 3/31/1999 6/3/1999 9/29/ /29/1999 3/29/2 6/28/2 9/27/2 12/27/2 3/28/21 6/27/21 9/26/21 12/26/21 3/27/22 6/26/22 9/25/22 12/25/22 3/26/23 6/25/23 9/24/23 12/24/23 The Five-Year Total Return Treasury Index (Bar Total Bank Holdings of U.S. Government Securities (Line in billions $ Total Bank Holdings of U.S. Government Securities in billions of dollars (Red line and right scale) The Five-Year Total Return Treasury Index (Bars and left scale)

7 Measuring The Carry Trade - 1 Normally cheap financing alone is not enough to entice leveraged speculators to act. But, when it is combined with a promise to hold the targeted funds rate at a certain level for a considerable period, they see an opportunity to profit and they jump on it. The chart below shows the futures traders that act most like leveraged fixed-income speculators the large speculators in the 2-year and 5-year Treasury note futures. The red box highlights the period that the Fed used the phrase considerable period (it was first used by Chairman Greenspan in his July 15 Congressional testimony and believed to be in force until it was dropped at the January 28 FOMC statement). When the Fed started using considerable period, notice how the leveraged speculators moved Net Large Speculators - 5 Year Notes to an extreme net long position. 2 2 We believe they were betting on the target fed funds rate staying at % and using that cheap financing to buy higher yielding Treasury 8 8 securities out to five years. We believe this activity has been the 4 4 driving force in holding interest rates down despite strong -4-4 economic growth, a falling dollar, rising commodity prices, and a -8 Speculators are those that do not deal in the cash market and have more than 8 contracts -8 booming stock market. Net Positions (in 's) Net Positions (in 's) /4/2 5/9/2 9/12/2 1/16/21 Net Large Speculators - 2 Year Notes Speculators are those that do not deal in the cash market and have more than 5 contracts 5/22/21 9/25/21 1/29/22 6/4/22 1/8/22 2/11/23 6/17/23 1/21/23 2/24/ Net Positions (in 's) Net Positions (in 's) What does this have to do with the payroll report? The Fed has consistently offered two reasons for maintaining this accommodative policy strong productivity growth and low wage inflation. What do these two concepts have in common? Answer: the payroll report. The payroll report is used to calculate both productivity and wage inflation (unit labor cost). Bianco Research, L.L.C February 12, 24 7

8 Measuring The Carry Trade Bond Market Leverage Primary Dealer Net Borrowings (Total Repos less Total Reverse Repos) 85 8 Considerable Period /29/1999 3/8/2 5/17/2 7/26/2 1/4/2 12/13/2 2/21/21 5/2/21 7/11/21 9/19/21 11/28/21 2/6/22 4/17/22 6/26/22 9/4/22 11/13/22 1/22/23 4/2/23 6/11/23 8/2/23 1/29/23 1/7/24 3/17/24 Billions Of Dollars Billions Of Dollars Bianco Research, L.L.C February 12, 24 8

9 Household Versus Payrolls - 1 In recent months, the accuracy of the payroll report has been questioned. It is not consistent with other measures of job growth. This chart shows the total civilian employment (as measured by the Census Department via a survey of households) and total non-farm payrolls (as measured by the Bureau of Labor Statistics via a survey of established businesses). Since the end of the recession, these two series have been diverging. The household survey shows literally millions of jobs have been created while the total non-farm payrolls survey shows a net loss of jobs over the same period. Total Civilian Employment (Millions) - Thin Blue Lin Shaded Area = Recession Two Different Views Of The Jobs Market Total Civilian Employment (Household Survey) Left Scale Jan- May- Sep- Jan-1 May-1 Sep-1 Jan-2 May-2 Sep-2 Jan-3 May-3 Sep-3 Jan Total Non-Farm Payrolls (Millions) - Thick Red Lin Total Non-Farm Payrolls (Establishment Survey) Right Scale Bianco Research, L.L.C February 12, 24 9

10 Household Versus Payrolls - 2 The chart to the right shows a rolling two-year correlation between the household survey and total non-farm payrolls. This measure is an attempt to show how similar these two series have been. (Note for the statistically minded: any rolling correlation from 6 months out would yield similar results). The current divergence is far and away the largest ever seen. All previous divergences occurred after recessions (like the current one), but none saw the rolling correlation drop this far. In all the other instances, the correlation stayed positive during the divergence. This means total civilian employment and total non-farm payrolls moved in the same direction but the slope of the lines differed. The current divergence is the first time these two measures have moved in opposite directions. 1% 8% 6% 4% 2% % -2% -4% -6% -8% -1% Jan-49 Oct-52 Jul-51 Jan-54 Comparing Two Measures Of Total Employment The Rolling 2-Year Correlation of Total Civilian Employment (Household Survey) and Total Non-Farm Payrolls (Establishment Survey) Jul-56 Jan-59 Jul-61 Nov-61 Shaded Area = Recession Jan-64 Jul-66 Jan-69 Jul-71 Jul-71 Jan-74 Jul-76 Jan-79 Jul-81 Aug-83 Jan-84 Jul-86 Jan-89 Jul-91 Oct-92 Jan-94 Jul-96 Jan-99 Jul-1 Jan-4 1% 8% 6% 4% 2% % -2% -4% -6% Largest Divergence Ever! -8% Sep-3-1% Bianco Research, L.L.C February 12, 24 1

11 Other Employment Measures 25, 23, 21, Challenger Gray & Christmas US Job Cut Announcements Index Blue Line = Monthly Plot Red Line = 12 Month Average 25, 23, 21, 19, 19, 17, 17, The Small Business Hiring Plans Index published by the National Association of Independent Business (NFIB) is booming (below). Yes, this is a survey of intentions and not actual hiring. That said, it has been moving higher for months and some of these intentions should have translated into actual hiring. Again, this is also consistent with total civilian employment rising and not with total non-farm payrolls falling. 15, 13, 11, 9, 7, 5, 15, 13, 11, 9, 7, 5, Small Business Hiring Plans Index (Source: National Association of Independent Businesses) , 1, Jan- May- Sep- Jan-1 May-1 Sep-1 Jan-2 May-2 Sep-2 Jan-3 May-3 Sep-3 Jan-4 3, 1, The Challenger Gray & Christmas US Jobs Cuts Announcement Index is down about a third from 2 through 23 (above). This trend also appears when looking at the 12-month average (red line), which is more consistent with total civilian employment rising than with total non-farm payrolls falling Jan- May- Sep- Jan-1 May-1 Sep-1 Jan-2 May-2 Sep-2 Jan-3 May-3 Sep-3 Jan-4 Bianco Research, L.L.C February 12, 24 11

12 The Market s Outlook For Fed Policy 1.6 The Changing Perceptions Of The Fed Fund Futures Market Actual Target Federal Funds Rate Forecasted Federal Funds Rate (Implied rate from the fed fund futures market) /1/ /28/ /22/ /28/23 4/17/23 5/7/23 5/27/23 6/16/23 7/6/23 7/26/23 8/15/23 9/4/23 9/24/23 1/14/23 11/3/23 11/23/23 12/13/23 1/2/24 1/22/24 2/11/24 3/2/24 3/22/24 4/11/24 5/1/24 5/21/24 6/1/24 6/3/24 7/2/24 8/9/24 8/29/24 9/18/24 1/8/24 1/28/24 11/17/24 12/7/24 Bianco Research, L.L.C February 12, 24 12

13 Bianco Research L.L.C West Armitage, Suite 4 Chicago IL 6614 Phone: (847) Fax (847) research@biancoresearch.com Arbor Research & Trading, Inc. 1 Hart Road, Suite 26 Barrington IL 61 Phone (847) Fax (847) inforequest@arborresearch.com For more information about the contents/ opinions contained in these reports: President (847) James A. Bianco jbianco@biancoresearch.com Research Analysts (847) /1534 John J. Kosar jkosar@biancoresearch.com Greg Blaha gblaha@biancoresearch.com Neil Bouhan nbouhan@biancoresearch.com For subscription/service Information: Arbor Research & Trading, Inc. Director of Sales & Marketing (8) Fritz Handler fritz.handler@arborresearch.com Patrick Lovett pat.lovett@arborresearch.com Peter Forbes peter.forbes@arborresearch.com For more information about Arbor Research & Trading and its services: Director of Fixed-Income Sales (8) Daniel Lustig dan.lustig@arborresearch.com Director of International Sales (847) James L. Perry james.perry@arborresearch.com Arbor Research & Trading (UK) LTD 75 Cannon Street London England EC4N 5BN Phone Fax For more information: Director of Arbor (UK) Neil Tritton neil.tritton@arborresearch.com Ben Gibson ben.gibson@arborresearch.com Richard Stephenson richard.stephenson@arborresearch.com Copyright 24 Bianco Research, L.L.C. All rights reserved. This material is for your private information, and we are not soliciting any action based upon it. This material should not be redistributed or replicated in any form without prior consent of Bianco Research. The material is based upon information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied upon as such.

Bianco Research L.L.C.

Bianco Research L.L.C. An Arbor Research & Trading Affiliated Company Independent Objective Original Updating Leverage In The Bond Market Presentation Package November 18, 4 Long-Term Interest Rates -